Thursday, April 4th, 2013
April 3, 2013
by Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research
• Emerging markets have great promise—but we see constraints on future growth in large EM economies, and stocks have underperformed recently.
• Meanwhile, inflation is stubbornly high in several large countries, which could result in monetary tightening that further slows growth.
• We are cautious on emerging markets as an asset class, and see better opportunities in developed markets such as Europe and Japan.
The large emerging-market economies of Brazil, China and India have run into growth, inflation, and structural challenges. Combine that with a potential peak in commodity prices that could damage heavy commodity exporters such as Brazil, South Africa, Russia, Indonesia and Chile, and we see reason to be cautious on emerging markets (EM) as an asset class.
High economic growth doesn’t assure strong stock performance
Just five years ago, emerging markets, including the BRIC sub-group (Brazil, Russia, India and China) showed great promise. Chinese and Indian incomes were growing; Brazil and Russia boasted abundant and valuable natural resources; and low government debt and high levels of foreign exchange reserves in many emerging markets seemed to pave the way for rapid growth.
Emerging-market growth steps down
Source: FactSet, IMF. Estimates used after vertical line are as of Oct. 2012, World Economic Report database.
Unfortunately, growth rates have taken a noticeable step down, and emerging-market stocks have underperformed over the past two years. Some investors have held on to emerging-market allocations on the premise that the growth outlook for these countries remains above that in the developed world.
Paradoxically, higher economic growth doesn’t always equate to the best investment returns—academic research suggests no clear correlation. While stronger economic growth creates the potential for greater sales growth, high earnings per share and dividend growth don’t necessarily follow. Profits can suffer if wages rise faster than productivity increases. Weak corporate governance can reduce returns when profits are expropriated rather than passed along to shareholders. Additional capital can be needed to sustain high growth, which can reduce shareholder returns.
The role of expectations and valuations is also very important. High growth expectations can be accompanied by high valuations, resulting in future underperformance—the good news is priced in. We believe that missed growth expectations in emerging markets are the likely culprit for the underperformance over the past two years.
Emerging market growth may have difficulty improving
So are expectations now low enough to get in? We view valuation as an important basis for future performance, but not the only factor. We are cautious on emerging markets (EM) as an asset class due to growth constraints for 60% of the weight in the universe, as defined by the MSCI Emerging Market Index. We believe addressing these constraints could involve difficult transformations or decisions by policymakers in the largest countries.
• A combination of stagflation and structural issues in the large emerging market economies of Brazil, China and India, which represent 40% of the MSCI Emerging Market Index.
• Commodities are potentially peaking, which represents roughly 20% of the MSCI Emerging Market Index, excluding Brazil (included above).
China: Still growing, but sources are suspect
Construction spending has been the primary driver of China’s economic growth in recent years, but it was fueled by a massive issuance of debt, which grew at 30% of GDP for four straight years. That rate of growth can’t continue forever, so we think property and infrastructure construction will likely slow from the rapid pace of the past. Additionally, the overhang of debt could result in a credit crunch that reduces growth for the overall economy.
China’s government is trying to transition to a more consumer-led economy, which will likely be an eventual positive for consumer spending—but we could see policy mistakes and uneven economic progress along the way. It’s much harder for a government to control consumer spending than it is to order new infrastructure construction or command a state-owned company to build another factory. Wages are rising, which benefits consumers, but sales and labor productivity are slowing, constraining corporate profits. Corporations have had difficulty with pricing power.
Additionally, China has a host of challenges related to the growth of its shadow banking sector. See more in “China’s Hidden Risks: Shadow Banking and US Delisting” and “Avoid China – Subprime-Like Bubble Brewing.”
China’s debt-fuelled growth potentially unsustainable
Source: FactSet, People’s Bank of China, Bloomberg. In current dollars using the December 31, 2012 exchange rate. Total credit as measured by total social financing. As of January 29, 2013.
Brazil: Stressed consumers and government bureaucracy
Brazil’s economy relies heavily on consumers, who represent 60% of GDP—and right now, consumers are challenged by inflation and high levels of household debt.
Inflation in Brazil accelerated to 6.3% in February and has exceeded the central bank’s 4.5% target for more than two years. The country’s tight labor market could further propel inflation. With flagging productivity gains and low unemployment, employers won’t find it easy to get more productivity out of the existing workforce or hire lower-wage workers—which means that rising wages may be next. This is good for workers, but often leads to accelerating inflation.
Additionally, the rapid growth in consumer credit that helped to fuel Brazil’s economy in recent years may now be waning. Brazil’s households spend roughly 20% of their disposable income servicing debt, compared to 14% at the peak for the US consumer in 2007, according to Capital Economics. With consumers spending so much money servicing debt, there’s little disposable income left over for new consumption.
Brazil’s consumers are tapped out on credit
Source: FactSet, Banco Central do Brasil, Bloomberg. As of March 15, 2013. *Household debt is the sum of consumer loans outstanding and housing loans outstanding.
On the business side, government bureaucracy and increased interference in the private sector has created a difficult operating environment—particularly for the two largest stocks in the Bovespa Index, as well as utilities and banks. For example, the government limited the price Petrobras could charge for petrol fuel in order to dampen inflation—but this reduced profits for the oil company. Meanwhile, Brazil’s central bank has pursued a somewhat volatile monetary policy. It has overshot at times, creating volatility in both growth and inflation, and has instituted controls that limit foreign investment.
India: Reforms needed, but hopes fading
Economic growth in India has roughly halved from the 9-10% range in the late 2000s to a 4.5% annualized rate as 2012 ended, well below the country’s 8% growth goal. From a funding perspective, India suffers from both a large fiscal deficit and the need for foreign investment due to low savings rates. Therefore, reforms to reduce fiscal spending and attract investment are important to reinvigorate growth.
India’s fiscal deficit expected to worsen before it improves
Source: FactSet, Bloomberg, India Central Statistical Organization. Estimates used after vertical line are provided by India Central Statistical Organization. As of March 15, 2013.
The fiscal budget released in February 2013 was a disappointment for investors hoping for reforms. The budget projected optimistic revenue increases and placed a greater tax burden on corporations, but lacked reforms to spending, preserving populist measures such as costly fuel, food and fertilizer subsidies. Reforms to open the economy to competition announced in 2012 were a positive first step, but momentum has stalled and the possibility of progress ahead of elections in April 2014 is fading.
Meanwhile, inflation is stubbornly high due to swings in food prices, which constitute a large portion of consumer spending. This volatility is the result of supply bottlenecks that stem from insufficient power and warehouse facilities, low agriculture yields, an inefficient public food-distribution system and dependence on the unpredictable monsoon season for irrigation.
Commodity prices may be peaking
As emerging-market economies continue to build out infrastructure and housing, they’ll support demand for commodities such as industrial metals and construction materials. However, the pace of demand growth is likely to slow. China constitutes 40% of demand for many commodities right now, and we expect slower growth in future demand from China as construction of infrastructure and property slow. We don’t see any countries that could replace China as a major commodities consumer—both Brazil and India are potential candidates, since they appear to need large investments in infrastructure, but government bureaucracies and lack of funding are barriers to progress.
Revenues for commodity producers are a function of both demand (where we expect slower volume gains) and prices. Prices of some commodities may have difficulty increasing, as demand growth in the past was met with significant increases in supply. Stagnant commodity revenues could be a challenge to economic growth for the commodity-oriented emerging economies of Brazil, South Africa, Russia, Indonesia and Chile.
Commodity prices have yet to gain traction
Source: FactSet, Commodity Research Bureau. As of March 15, 2013.
Monetary policy may tighten
In Brazil, central bank chief Alexandre Tombini said in February that he was “uncomfortable” with current inflation levels and that the bank will not hesitate to raise rates. At its March 6 meeting, the central bank removed the language (used since October) that it would maintain monetary policy for a “prolonged period of time,” suggesting it has shifted its priority from encouraging growth to fighting inflation. Brazil was the first major emerging-market country to ease in August of 2011, and its moves could be reflective of broader trends.
Inflation still a concern in Brazil and India
Source: FactSet, IBGE, Indian Ministry of Labor. As of March 15, 2013.
In China, Governor Zhou of the People’s Bank of China (PBoC) noted in March that China should be on “high alert” as inflation could accelerate later this year. As a result, monetary policy in China is now in “neutral” territory, and the next move for the PBoC is more likely to be tightening than easing.
Attractive valuations, but disappointing earnings
In a fourth straight quarter of disappointing results, more than 59% of companies in the MSCI BRIC Index reported quarterly earnings that trailed analyst estimates, while profits rose less than 1%, according to Bloomberg. Earnings estimates for emerging markets may still be overly optimistic, as economic growth continues to come in below expectations.
Consumers in some countries (such as Brazil) and other borrowers (such as local governments in China) appear tapped out on credit, and without credit to help fuel consumption we may see slower economic growth. Additionally, rising labor costs in many emerging markets could put a damper on corporate profits. While valuations appear attractive relative to historical averages, lower growth and potentially unmet estimates will likely necessitate lower valuations until these trends turn around.
As long as China’s economic reacceleration continues, emerging-market investments could benefit in the short term. However, we believe longer-term investors may want to consider re-orienting international exposure away from China and emerging markets and toward developed international markets. Earnings in non-US developed markets such as Europe and Japan have been cut quite dramatically, and economic data has shown steady (albeit modest) improvement. Additionally, valuations in Europe and Japan look low relative to historical averages, so stocks in these markets could be a relative bargain.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
The MSCI BRIC Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the following four emerging market country indices: Brazil, Russia, India and China.
The Bovespa Indexis comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange, and serves as the main indicator of the Brazilian stock market’s average performance.
Copyright © Charles Schwab and Co.
Wednesday, February 27th, 2013
Submitted by Felix Imonti of OilPrice.com,
Russia is back. President Vladimir Putin wants the world to acknowledge that Russia remains a global power. He is making his stand in Syria.
The Soviet Union acquired the Tardus Naval Port in Syria in 1971 without any real purpose for it. With their ships welcomed in Algeria, Cuba or Vietnam, Tardus was too insignificant to be developed. After the collapse of the Soviet Union, Russia lacked the funds to spend on the base and no reason to invest in it.
The Russian return to the Middle East brought them first to where the Soviet Union had had its closest ties. Libya had been a major buyer of arms and many of the military officers had studied in the Soviet Union. Russia was no longer a global power, but it could be used by the Libyans as a counter force to block domination by the United States and Europeans.
When Gaddafi fell, Tardus became Russia’s only presence in the region. That and the discovery of vast gas deposits just offshore have transformed the once insignificant port into a strategic necessity.
Earlier at the United Nations, Russia had failed to realize that Security Council Resolution 1973 that was to implement a new policy of “responsibility to protect” cloaked a hidden agenda. It was to be turned from a no-fly zone into a free-fire zone for NATO. That strategic blunder of not vetoing the resolution led to the destruction of Gaddafi’s regime and cost Russia construction contracts and its investments in Libyan gas and oil to the tune of 10 billion dollars.
That was one more in a series of humiliating defeats; and something that Putin will not allow to happen again while he is president. Since his time as an officer in the KGB, he has seen the Soviet Empire lose half of its population, a quarter of its land mass, and most of its global influence. He has described the collapse of the Soviet Union as a “geopolitical catastrophe.”
In spite of all of the pressure from Washington and elsewhere to have him persuade Bashar Al-Assad to relinquish power, Putin is staying loyal to the isolated regime. He is calculating that Russia can afford to lose among the Arabs what little prestige that it has remaining and gain a major political and economic advantage in Southern Europe and in the Eastern Mediterranean.
What Russia lost through the anti-Al-Assad alliance was the possibility to control the natural gas market across Europe and the means to shape events on the continent. In July 2011, Iran, Iraq, and Syria agreed to build a gas pipeline from the South Pars gas field in Iran to Lebanon and across the Mediterranean to Europe. The pipeline that would have been managed by Gazprom would have carried 110 million cubic meters of gas. About a quarter of the gas would be consumed by the transit countries, leaving seventy or so million cubic meters to be sold to Europe.
Violence in Iraq and the Syrian civil war has ended any hope that the pipeline will be built, but not all hope is lost. One possibility is for Al-Assad to withdraw to the traditional Aliwite coastal enclave to begin the partitioning of Syria into three or more separate zones, Aliwite, Kurdish, and Sunni. Al-Assad’s grandfather in 1936 had asked the French administrators of the Syrian mandate to create a separate Aliwite territory in order to avoid just this type of ethnic violence.
What the French would not do circumstance may force the grandson to accept as his only choice to survive. His one hundred thousand heavily armed troops would be able to defend the enclave.
The four or five million Aliwites, Christians, and Druze would have agricultural land, water, a deep water port and an international airport. Very importantly, they would have the still undeveloped natural gas offshore fields that extend from Israel, Lebanon, and Cyprus. The Aliwite Republic could be energy self-sufficient and even an exporter. Of course, Russia’s Gazprom in which Putin has a vital interest would get a privileged position in the development of the resource.
In an last effort to bring the nearly two year long civil war to an end, Russia’s foreign minister Sergei Lavrov urged Syrian president Bashar al-Assad at the end of December to start talks with the Syrian opposition in line with the agreements for a cease fire that was reached in Geneva on 30 June. The Russians have also extended the invitation to the Syrian opposition National Coalition head, Ahmed Moaz al-Khatib. The National Coalition refuses to negotiate with Al-Assad and Al-Assad will not relinquish power voluntarily.
The hardened positions of both sides leaves little hope for a negotiated settlement; and foreign minister Sergei Lavrov has made it clear that only by an agreement among the Syrians will Russia accept the removal of Al-Assad. Neither do they see a settlement through a battlefield victory which leaves only a partitioning that will allow the civil war to just wind down as all sides are exhausted.
The Russians are troubled by what they see as a growing trend among the Western Powers to remove disapproved administrations in other sovereign countries and a program to isolate Russia. They saw the U.S involvement in the Ukraine and Georgia. There was the separation of Kosovo from Serbia over Russian objections. There was the extending of NATO to the Baltic States after pledging not to expand the organization to Russia’s frontier.
Again, Russia is seeing Washington’s hand in Syria in the conflict with Iran. The United States is directing military operations in Syria with Turkey, Qatar, and Saudi Arabia at a control center in Adana about 60 miles from the Syrian border, which is also home to the American air base in Incirlik. The Program by President Obama to have the CIA acquire heavy weapons at a facility in Benghazi to be sent to Turkey and onward to Syria is the newest challenge that Putin cannot allow to go unanswered. It was the involvement of Ambassador Chris Stevens in the arms trade that may have contributed to his murder; and the Russians are not hesitating to remind the United States and Europeans that their dealings with the various Moslem extremists is a very dangerous game.
The Russians are backing their determination to block another regime change by positioning and manning an advanced air defense system in what is becoming the Middle East casino. Putin is betting that NATO will not risk in Syria the cost that an air operation similar to what was employed over Libya will impose. Just in case Russia’s determination is disregarded and Putin’s bluff is called, Surface to surface Iskander missiles have been positioned along the Jordanian and Turkish frontiers. They are aimed at a base in Jordan operated by the United States to train rebels and at Patriot Missile sites and other military facilities in Turkey.
Putin is certain that he is holding the winning hand in this very high stakes poker game. An offshore naval task force, the presence of Russian air defense forces, an electronic intelligence center in latakia, and the port facilities at Tardus will guarantee the independence of the enclave. As the supplier of sixty percent of Turkey’s natural gas, Moscow does have leverage that Ankara will not be able to ignore; and Ankara well knows that gas is one of Putin’s diplomatic weapons.
When the Turks and U.S see that there is little chance of removing Al-Assad, they will have no option other than to negotiate a settlement with him; and that would involve Russia as the protector and the mediator. That would establish Russia’s revived standing as a Mediterranean power; and Putin could declare confidently that “Russia is back.” After that, the Russians will be free to focus upon their real interests in the region.
And what is Russia’s real interest? Of course, it is oil and gas and the power that control of them can bring.
Copyright © OilPrice.com
Wednesday, September 26th, 2012
In what is likely the biggest sabre being rattled this week in the war-of-words that is occurring in the Pacific, China announced today the launch of its first aircraft carrier. China bought the 300-meter Soviet-built vessel in 1998 from Ukraine and had it refitted at Dalian. It is named Liaoning (which looks almost too much like ‘leaning’) after China’s northeast province where the port is located. The defense ministry said the aircraft carrier, is an important step in “raising the overall fighting capacity” of its naval forces.
Rear Admiral Yang Yi noted that “it is natural that China should have its own aircraft carrier,” arguing that all major world powers already own similar vessels. Of course, the coincidental timing is no surprise as Reuters notes “China will never tolerate any bilateral actions by Japan that harm Chinese territorial sovereignty,” Vice Foreign Minister Zhang Zhijun told his Japanese counterpart on Tuesday as the two met in a bid to ease tensions.
“Japan must banish illusions, undertake searching reflection and use concrete actions to amend its errors, returning to the consensus and understandings reached between our two countries’ leaders.”
Stratfor provides some more color on the current state-of-play (and some history)… as Taiwanese water-squirting was underway (no, seriously!!)
[AA's note] If you’ve read Jeff Rubin’s ‘The End of Growth,’ then you know all about how this aircraft carrier, the Varyag, came in to China’s possession. China surreptitiously bought this (then rusting hulk of a) vessel from the Ukraine, following the economic breakup of Russia CIS (the reason this carrier’s construction was halted) under the false pretense of using it as a research vessel or perhaps a floating casino, and promised the vendor that it would not be fitted for its original intended use. The rest is academic, as China has flexed its muscle, with its announcement.
China’s imperative to protect its own economic interests, as well as its access to resources, is becoming more apparent, and transparently obvious. [AA]
Tuesday, September 25th, 2012
by Neuberger Berman Investment Strategy Group
The “BRIC” countries have been a focal point of investor interest since the early 2000s. Brazil, Russia, India and China account for about half of the world’s population, boast vast natural resources and are among the fastest-growing economies in the world. That said, progress at times has been uneven. Since 2010, the MSCI BRIC Index has largely underperformed the S&P 500 as economic growth flagged. In this edition of Strategic Spotlight, we discuss current conditions and the outlook for these markets.
Following the global financial crisis of 2008–2009, the BRIC countries enjoyed a strong economic rebound as forceful policy measures reignited growth. However, a surge in capital inflows stoked inflation and led to tightening measures in 2010 and 2011. Currently, the BRICs are experiencing varying stages of easing as growth and inflation decline. Unlike the synchronous rebound we saw in 2009, progress in the BRIC countries is diverging due in part to idiosyncratic policy initiatives aimed at managing structural changes within their specific economies.
BRIC GROWTH RATES HAVE SLOWED
Brazil’s real GDP growth declined from 9.3% in the first quarter of 2010 to 0.5% in the second quarter of 2012—a number that disappointed investors looking for 3.5% GDP growth for all of 2012. The slowdown is partly a function of so-called macro-prudential measures—meant to fight inflation and control the appreciation of the real currency due to capital inflows—as well as a slowdown in exports. The tightening measures have had the desired impact of reducing inflation from 7.2% from last September to 4.1% in August 2012, but have also caused investment spending to plummet as the outlook for commodities (a key sector for Brazil) deteriorated. Domestic consumption, which accounts for about 60% of Brazilian GDP, has held up surprisingly well, supported by the country’s still-low unemployment rate.
Since the end of 2011, the Brazilian central bank has reduced interest rates, complementing the government’s recent accommodative fiscal measures such as payroll tax cuts. The OECD expects growth to pick up gradually in the third quarter as these measures work through the system.
Russia: The Limitations of Oil
The Russian economy has held up reasonably well in the past few years despite turmoil in Europe. Since the end of June 2012, real GDP has grown at around 4% annually, which is close to the post-crisis peak of around 5% in 2010. This good fortune is mainly due to relatively high oil prices and, most recently, fiscal spending ahead of the presidential elections in March 2012. Unlike Brazil, Russia is grappling with rising inflation as record-low unemployment has supported wage growth. In September, the country’s central bank surprised investors by hiking interest rates as inflation had come in above the bank’s target range of 5%–6%.
For the most part, Russia’s domestic consumption has been strong but the impact of declining oil demands from key trading partners such as Europe and China could have spillover effects—weakening the outlook for budget and current account balances. Concerns about an overheating economy have led to predictions that further tightening measures could be introduced, marginally reducing growth in 2013.
PERFORMANCE AND VALUATIONS
Source: FactSet as of Sept 17, 2012.
Despite a year-to-date equity market return of about 20% (see display), India’s real GDP growth continuously slowed to about 4% in the second quarter—a level last seen during the crisis of 2008–2009. Declining global growth, reductions in foreign investments and monetary tightening measures have contributed to a slowdown in manufacturing and services. In June, government agencies reported that foreign direct investments had decreased by as much as 67% from a year ago, as economic reforms stalled and business conditions were increasingly viewed as being biased against foreigners.
In addition, India is dealing with rising consumer price inflation, as recent cuts in government fuel subsidies and the effects of the monsoon season feed through the system. Consumer price inflation ramped up to 10% in August, reducing the scope for further rate cuts by the Reserve Bank of India. Moreover, warnings of a downgrade have been issued by rating agencies, given that India’s government finances are weaker than other BRIC countries. Investors are closely watching reform measures designed to promote competition and improve market efficiency following the decision last week to expand foreign companies’ access to the retail and airline industries.
China: Political Transitions
Recent data indicate that China continues to slow from tightening measures enacted in 2010–2011 and a decline in exports. Investors have been somewhat surprised by the government’s passivity toward this slowdown. Following small cuts in interest rates and reserve requirement ratios earlier in the year, the People’s Bank of China (PBoC) has not done more despite inflation dipping below its 3%–4% target. And while most analysts did not expect a repeat of the 2008–2009 RMB 4.0T fiscal stimulus, the government has acted less forcefully than expected.
The failure to act could be a result of widely reported complications in the current once-in-a-decade change to the country’s political leadership. Moreover, the PBoC could be concerned about magnifying the inflationary impact of loose monetary policy in developed countries. The political transition is expected to conclude by March 2013, potentially paving the way for better policy engagement. Regardless, the IMF expects China’s growth to reaccelerate next year.
A More Nuanced Progression
In the past decade, the BRIC countries have experienced rapid growth, but are now showing signs of slowing down as cheap labor and abundant resources are beginning to yield a diminishing impact on their economies. As such, investors should consider looking towards the rising middle class to lead the charge in driving growth.
Before we reach that point, however, we believe some structural reforms will need to be made. Investors should remain vigilant of the various policy prescriptions during this period to avoid potential speed bumps. Not every policy change will be successful, but if imbalances are adequately addressed, the BRIC countries should continue to offer investment opportunity.
This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The views expressed herein are generally those of Neuberger Berman’s Investment Strategy Group (ISG), which analyzes market and economic indicators to develop asset allocation strategies. ISG consists of five investment professionals who consult regularly with portfolio managers and investment officers across the firm. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events may differ significantly from those presented. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
Sunday, September 16th, 2012
Emerging Markets Radar (September 17, 2012)
- New home sales, residential investments and housing starts in China all showed an encouraging recovery in August, registering 13 percent, 10 percent, and 5 percent year-over-year growth, respectively, as lower interest rates and policy relaxation for first-time home buyers continued to help housing transactions normalize.
- South Korea announced a $5.2 billion stimulus package aimed at reducing taxes on individual income and home and auto purchases as well as expanding social welfare programs. Combined with $7.5 billion introduced in June, cumulative government initiative for this year equals 1 percent of GDP. The country’s debt rating was upgraded one notch to A+ by S&P this week.
- Turkish Airlines’ passenger numbers increased by 19 percent year-to-date in August. After a slowdown in July 2012 due to Ramadan, which negatively affected mainly Middle Eastern air traffic, the carrier again posted a strong increase in load factor, up 5.2 percent. Meanwhile, favorable passenger mix development continues as business class passenger count was up 45 percent year-to-date.
- China’s industrial production growth in August came out lower than expected at 8.9 percent year-over-year, the first monthly pace below 9 percent since May 2009, as a slight stabilization in heavy industry output failed to offset a retreat in light industry. Deterioration in the metric with the highest historical correlation to GDP lowers the probability of a near-term growth recovery in China.
- China’s passenger car sales grew 11 percent year-over-year in August to a lower-than-estimated 1.22 million units, as dealer inventories remained higher than normal and consumers postponed purchases in anticipation of more price discounts. Total auto sales rose 8.3 percent to 1.5 million, as commercial vehicle sales stayed weak.
- China’s total imports declined by 2.6 percent year-over-year in August, the first year-over-year decline since October 2009 excluding seasonal distortions from the Chinese New Year, another indicator of feeble domestic demand and continued de-stocking.
- New EU banking union proposals are designed so that non-euro countries can join if they wish. Austrian bank regulators expressed their support for the new eastern members of the EU to join. Austrian banks are the biggest lenders in Southeastern Europe.
- Iraq’s central government and the Kurdish regional government struck a preliminary deal on Thursday on a months-long oil dispute that will see the autonomous region export 200,000 barrels of oil per day, officials said. Any resolution of the long standoff will help crystallize valuation of the energy companies with exploration projects in the area.
- The launch of the third round of quantitative easing (QE3) by the U.S. Fed brings new hope for emerging Asian markets in general. Based on the historical parallel of what happened to different equity sectors in the near term after the Fed’s formal announcement of QE2 in early November 2010, the technology sector in Asia tends to consistently outperform in this environment.
- A risk exists that policymakers in Asia may overreact to inflation prospects as a result of QE3-induced commodity price rallies and hot money inflows. The earliest sign was observed when Hong Kong’s monetary authority tightened mortgage lending immediately after the Fed’s QE3 announcement.
- According to the Turkish banking regulator bulletin, a large corporate loan on the banking sector’s balance sheet has gone bad. Next week, the list of banks that potentially have been hit by this default should be narrowed down.
- Moving counter to the global easing cycle, the Central Bank of Russia (CBR) decided to hike key interest rates by 25 basis points, with another hike now expected in the fourth quarter. The CBR elaborated on inflation risks and stated that headline inflation advanced to 6.3 percent, exceeding its target.
Saturday, September 8th, 2012
China’s Next Act
August 24, 2012
By Frank Holmes, CEO and Chief Investment Officer
U.S. Global Investors
The ECB calmed the markets—will China act next?
After Mario Draghi announced the European Central Bank’s new bond buying program, I was the first guest on CNBC Asia’s Squawkbox to weigh in on this decision. I reiterated my stance that the endgame for Europe would be to print money, which will eventually lead to currency wars. These actions are positive for gold and also for increased economic activity.
China too has kept investors on the edge of their seats, as we wait for some monetary or fiscal action. Everyday that goes by with no significant policy decisions from the Asian giant causes the market to lose confidence in its ability to steer its ship. Even the most optimistic bull can be vulnerable to a loss of confidence.
It often helps to gain a different perspective, which is what a business trip halfway around the world can provide.
I’ve been traveling in Singapore (and then onto Hong Kong) and I continue to be amazed by the juxtaposition of the vibrancy of the Asian continent compared to investor sentiment in the States. It’s a subtle difference, but you can see it in the faces of people walking the cities, you can feel it when talking with local entrepreneurs and you can read it in a speech from local government leaders.
Singapore’s Prime Minister Lee Hsien Loong provided a beam of light to a Beijing audience only days ago. During his speech at the Central Party School, the prime minister discussed China’s significance in the world as it relates to political relations, government policies, and world trade. He also touched on his country’s role in facilitating a solid relationship between the Asian giant and the world’s largest economy.
By nature, public speeches are meant to be uplifting, as they tend to reflect on a long period of history and focus on positive solutions. However, I believe new opportunities cannot be found when all hope is believed to be lost.
The prime minister acknowledges China’s “serious and complex challenges” that it is facing after decades of significant growth. He says that its economic, social and political reforms are difficult for any nation to handle, “let alone one the size of China.” He believes it’s to be expected that “China’s leaders are preoccupied with these domestic priorities.”
However, China will not be tackling this alone, as the world has become so “inter-connected and inter-dependent,” with growing world trade, interlinked financial markets, and the growth of the Internet bringing one third of the world online today.
You can see how synchronized world economies are today by comparing manufacturing output. In August, China’s Government Purchasing Manufacturing Index (PMI) crossed below 50 for the first time since November 2011. (Remember that a reading of 50 marks the critical line delineating expansion from contraction.)
The U.S. ISM Manufacturing PMI also crossed below 50, with a reading of 49.6 in August. JP Morgan’s Global PMI came in at 48.1, and its been below 50 for the last three months.
Over the past decade, China has experienced incredible growth because of globalization. On one measure alone, the prime minister pointed out that more than one billion line workers, engineers, scientists and entrepreneurs are joining the international economy to develop, serve and produce goods for markets around the world.
Stephen Roach, a senior fellow at Yale University and author of The Next Asia, says China’s “grand plan” is to move from the “producer model, which worked brilliantly for 30 years” to one that needs to provide higher-paying, less labor intensive jobs, in new fully functional cities to the 350 million who are estimated to move to an urban area in China over the next 15 years. To paraphrase Marshall Goldsmith’s self-improvement book for business executives, what got China here, won’t get China there.
The Asian giant can take a few lessons from its developed neighbors, says BCA Research. China has already experienced a tremendous population shift from its farms and rural areas to the cities in search of higher paying jobs. But there comes a tipping point when labor supply in the cities goes from “feast to famine,” says BCA.
The research firm says in the previous cases of Japan, Korea and Taiwan, there have been similar employment phases. First, when industrialization just begins, “demand for labor is strong, but wages are low because of plentiful supply.”
Then, wages grow faster than labor demand. This is what we have been seeing in China today, as urban per capita income far exceeds rural incomes.
The last stage of this development that other Asian nations have experienced is when “wage growth accelerated and the wage gaps between the manufacturing and agriculture sectors disappeared,” according to BCA. Their research shows that cheap labor in manufacturing ends while growth of wages accelerates in both cities and farms.
It’s only a guess when China will make that labor shift to the stage where manufacturing sector competes with agriculture for jobs. BCA compared manufacturing employment to agriculture employment of Japan, Korea and Taiwan, looking at when these countries’ ratio rose above 1. In Japan, manufacturing labor shortages started in the early 1960s, for South Korea, it was around 1975-1976. Taiwan began experiencing this phenomenon around 1970.
Based on this ratio, it’s estimated that labor shortages could become more common around 2014-2015 for China, says BCA.
Until that tipping point is reached, China “will continue to need higher value-added, less labor-intensive production to sustain exports; policy and productivity will be critical to a continuation of the ‘growth miracle,’” according to BCA.
The way China will accomplish this is through good relations with the U.S., as well as taking an interest in making sure Asia is stable and prosperous. Loong believes the Chinese economy “depends on an open, inclusive and fair global trade system to thrive. It needs a stable external environment, and good relations with other countries, so that it can focus on economic development,” says Singapore’s leader. In Loong’s view, “China is no longer an isolated, self-sufficient Middle Kingdom.”
One example of how China will be engaging the world in its future growth is through its current energy policies. While 70 percent of the country’s energy consumption is coal, oil is the second source of energy, at nearly 20 percent of total energy consumption, according to the U.S. Energy Information Administration (EIA). In 2010, the country consumed an estimated 10 million barrels per day.
China only produces about 4 million barrels per day, and imports the remaining amount, making the Asian giant the second largest importer of oil, says the EIA. The largest importer of oil in the world has been the U.S., with an intake of 8.7 million barrels per day, according to the EIA. Japan imports the third most oil, at 4.3 million barrels per day.
The country currently has a diverse variety of sources from which it receives its oil, with most of the crude oil imports coming from Saudi Arabia, followed by Angola, Iran and Russia.
The country’s energy policies appear to be focused on three goals: 1) fulfill its growing demand for oil and reliance on oil imports, 2) diversify import sources to reduce its risk of supply disruption, and 3) develop technical expertise in unconventional resources. One way to accomplish these goals is through overseas acquisitions, which we’ve previously discussed. “China is taking advantage of the economic downturn to step up its global acquisitions and use its vast foreign exchange reserves (estimated at over $3 trillion in 2012) to help purchase equity in projects or acquire stakes in energy companies,” says the EIA.
A Hint of Action Arrives
World markets may not have to wait much longer for Chinese policymakers to act, as the government recently announced new infrastructure projects. According to Bloomberg, China approved 25 new subway construction projects, with related investments estimated to be more than 840 billion yuan. Railway, subway and construction stocks in China increased on the news.
Stephen Roach concludes his discussion about China this way: “A growth slowdown is hardly shocking for an export-led economy. But China is in much better shape than the rest of the world. A powerful rebalancing strategy offers the structural and cyclical support that will allow it to avoid a hard landing.”
Saturday, September 8th, 2012
Emerging Markets Radar (September 10, 2012)
- China’s NDRC announced city subway projects worth RMB 8.4 trillion, and highway and port projects worth RMB 1.2 trillion.
- Hong Kong August home sales rose to HK$39.7 billion from HK$31.77 billion in July.
- The government of Thailand is moving forward with next season’s rice-pledging program, which proposes Bt405 billion to buy rice. Inflation in Thailand was steady in August, up 2.69 percent versus 2.73 in July.
- China’s August PMI was 49.2 versus the estimated 50, which indicates that the economic activities are contracting. HSBC’s final August flash China PMI was 47.6 versus previous 49.3.
- Taiwan and Philippines both saw their August inflation spike due to summer floods, which caused shortage in many consumer goods.
- Malaysia exports in July were down 1.9 percent versus the consensus up 3.5 percent. Exports in July were up 5.4 percent. The Malaysia central bank left the benchmark interest rate unchanged at 3 percent this week.
- Thailand also left its policy benchmark interest rate unchanged at 3 percent this week.
- As the chart below shows, the China region still has high potential for further smartphone penetration, which will bring about many business opportunities for internet and smartphone suppliers.
- Russia’s Bazhenov foundation, which lies just below conventionally producing layers is holding anywhere between 80-140blln of hydrocarbons according to various estimates. While low permeability and porosity prevented oil extraction previously, advent of horizontal drilling, fracking and Western expertise are likely to repeat the success of unconventional oil development in the U.S. and Canada.
- China August PMI showed contraction in new orders and employment, but expansion in raw material and finished goods inventory or de-stocking.
- Hungarian Prime Minister Viktor Orban said he will present a brand new set of terms to the International Monetary Fund and the EU in upcoming aid talks. If the lenders insist on the conditions currently on the table, he said, the deal is off.
- A recent European Court ruling told Russia to compensate pensioners who had the purchasing power of their savings ruined by the hyperinflation of the 1990s. Total debt owed to households is at $786 billion, or 10 percent of the country’s GDP.
Saturday, September 1st, 2012
The Case for Emerging Europe
By Frank Holmes, CEO and Chief Investment Officer, uU.S. Global Investors
If history had turned out differently, the USSR would’ve taken home the most Olympic medals this year, as the total awarded to athletes from the area was 163, according to a blog on Foreign Policy’s website. As we all know, the Wall came down, the Soviet Union collapsed, and now Russia has to be content with its third-place position of 82 medals. Athletes from the United States were awarded the most medals (104), followed by participants from China, who took home 88.
In another contest, the U.S. stock market outperformed many developed and emerging equity markets for the year as of the end of August. Despite the negativity surrounding corporate earnings, lower economic growth and ongoing political uncertainty, the S&P 500 ETF rallied, climbing 13 percent through August 30.
By comparison, the iShares S&P Europe 350 ETF only rose 6.9 percent.
What seems to be overlooked by investors is the fact that stocks in Emerging Europe have also seen noteworthy results. As you can see in the chart below, the Eastern European Fund (EUROX) rose nearly 10 percent over the same time frame. Turkey was a significant contributor to those results, with stocks in the country climbing almost 40 percent; Russian stocks only advanced about 4 percent.
With the underperformance of the iShares S&P Europe 350 ETF, many investors have interpreted this as a contrarian sign to hunt for bargains in developed Europe. However, if you believe that Europe will see better days ahead, greater opportunity may lie to the east.
Here are three reasons to look at Emerging Europe stocks today:
1. Better GDP Growth Potential
The companies in the Eastern European area are located in countries set to grow faster than the U.S. and countries in Europe. Russia and Turkey are projected to have a GDP of about 4 percent this year, while Poland’s GDP growth is expected to be 2 to 3 percent.
2. Stocks are Undervalued
Along with benefiting from higher GDP growth, many of these stocks are historically undervalued. BCA Research looked at certain value metrics of several emerging market countries, including the trailing and forward price-to-earnings ratio and price-to-book ratios and compared these figures to the historical average going back to the early 1990s. Poland has a reading of about 1.2, which means that today’s price-to-earnings and price-to-book ratios are 1.2 standard deviations below the historical mean. Conversely, Mexico’s reading of -1.5 indicates that stocks in this country are historically overvalued.
Among emerging countries, Poland, Russia and Turkey are the better values, says BCA.
BCA also looked at the emerging markets where growth was expected to improve over the next five years compared to the previous two years. Among “the most favorably-placed markets” for valuation and economic growth were Russia and Poland.
3. Attractive Dividend Yields
Many Eastern European stocks pay attractive dividends, allowing investors to benefit from income and potential appreciation. As of June 30, 2012, the stocks in the EUROX portfolio had an average dividend yield of more than 5 percent.
Dividend income may not be the only benefit: According to research from ING Bank, there appears to be a healthy dividend effect on stock outperformance in emerging Europe.
The chart below shows the cumulative average outperformance 40 days before and 40 days after the ex-date among dividend-paying stocks in Europe, Middle East and Africa (EMEA) countries. The outperformance has historically started about 10 days before the ex-date and continues throughout the next 40 days. The ex-date is the day on or after which a security is traded without a previously declared dividend or distribution.
While this effect is seen throughout the EMEA countries, “Turkish stocks appear to be most attractive dividend effect plays with outperformance of 5 percent on average,” according to ING.
In today’s low yielding environment, dividends have been particularly attractive to investors. Martin Barnes, chief economist at BCA Research, writes to subscribers that he believes that in today’s uncertain environment, investors can still “build an equity portfolio of global companies with strong balance sheets, powerful brands and paying reliable and decent dividends. Not the most exciting investment strategy perhaps, but one that should pay off in the long-run.”
Price Reversal Indicates Attractive Entry Point?
As you can see below, over the past month, EUROX has moved above its 50-day moving average. This indicates to us that there is growing strength in the Eastern European area and an attractive entry point for investors.
The Eastern European Fund isn’t the only fund signaling a potential price reversal—all equity funds at U.S. Global Investors are above their 50-day moving average. Click here to see the charts.
|Eastern European Fund||-24.68%||7.09%||-10.06%||9.74%||1.98%|
|SPDR S&P 500 ETF||5.26%||16.23%||0.16%||5.23%||0.10%|
|iShares S&P Europe 350 ETF||-13.00%||-2.31%||-10.65%||-1.45%||0.60%|
Expense ratios as stated in the most recent prospectus. Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus (e.g., short-term trading fees of 2.00%) which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.
Dividend yields are as of 6/30/2012. These figures do not represent the funds’ yields, which may be materially different from the average yields of the stocks held in the funds.
For investment objective and risks regarding the Eastern European Fund, the SPDR S&P and the S&P Europe 350 ETFs, please see the disclosures section.
Saturday, September 1st, 2012
Emerging Markets Radar (September 2, 2o12)
- Central Huijin Investment, China’s government wealth management entity, picked up more A-shares of Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China in the second quarter, in hopes of boosting the market sentiment in China as regulators also called on companies to buy back their shares as their share price approaches book value.
- China’s third-quarter economy may rebound and be “slightly” higher than the second quarter as stable growth policies start to take effect, Xinhua reported, citing Hou Yunchun, a researcher at the State Council’s State Development Research Center.
- China will overtake the U.S. as the world’s largest smartphone market this year. China will account for 26.5 percent of smartphone shipments in 2012, compared with 17.8 percent for the U.S., research firm IDC said.
- About 2,453 publicly listed Chinese companies combined first-half profits falling 0.38 percent with no growth on a year-over-year basis, China Securities Journal said. For the second half of the year, Bank of America Merrill Lynch Global Research and CICC believe corporate earnings growth could accelerate as they think China will step up easing policies.
- High commodity prices have played a significant role in depressing Indian equities’ price performance. Lower commodity prices will help stabilize India’s relative performance against other emerging markets because they will at the margin boost profit margins as well as domestic liquidity, according to BCA.
- Thailand’s July exports fell 4.46 percent, lower than the consensus of -3.8 percent, but imports surged 13.7 percent on a year-over-year basis, resulting in a widening trade deficit of $1.75 billion.
- Here is a case in point that government policy is a precursor to change. In the Philippines, both monetary and fiscal policies are in favor of property and construction and consumer income growth, as the country is cutting interest rates and allocating the budget toward building infrastructure in the country. The chart below shows capital goods imports increased, an indication that construction is booming.
- Indian relative equity valuations are no longer excessive given that India’s return on equity and return on assets exceed, and will likely remain, above those of emerging markets counterparts, maintains BCA Research.
- Now that anti-corruption allegations have largely subsided, BCA Research expects the Indian government to approve a pipeline of pending projects. After a prolonged and messy hold up, this is not only positive for India’s power problems, but also for the nation’s banks, which have a sizable exposure to the power industry.
- Indonesia’s current account deficit widened to 3.1 percent GDP in the first half of the year as export commodity prices fell, while the domestic economy and consumptions were booming. Directly impacted by current account deficit, Indonesia’s currency was weakened, which, though not a structural issue, caused some market volatility lately.
- On the heels of the Republican convention, a Citibank strategist opined that a victory for Romney could drive the Russian equity market down by 5 to 10 percent. Romney’s foreign policy stance differs in two key areas that could damage the Russian market: 1) the ‘number one geopolitical foe’ rhetoric would elicit an equal and opposite reaction; and 2) a greater push for U.S. energy independence has important consequences for global oil markets.
- On the other hand, Romney’s foreign policy platform would bolster relationships with traditional bulwarks against aggressive behavior on the part of Russia, such as Poland and Turkey. He plans to decrease European energy reliance on Russia by helping to speed up development of shale gas in Poland. He would also aim to free Central Asian gas with construction of the Nabucco pipeline through Georgia and Turkey.
Friday, August 31st, 2012
by Mark Hanna, Market Montage
I wrote about a week ago that China was acting quite poorly relative to what was happening in European and U.S. markets. I guess yesterday a brokerage report hit that said the same thing and now a host of pundits are waving it around as a bearish signal. It shows how quickly group think is created on Wall Street as long as it originates from a major brokerage house. Whatever the case, while the U.S. is in some form of strange holding pattern with holiday type volume and an extremely narrow range post August 3rd spike up, some key overseas markets are weakening along with China. Now some of these are resource focused (Russia, Brazil, even Chile) so as a lot of commodity plays sell off after their early month reversion to mean spike, the sector rotation seems to be creating a big tailwind for those countries.
India has been relatively stronger among the BRICs, although it too has had a rough week.
If anything it seems the U.S. continues to benefit from the best house in a bad block syndrome. However without semiconductors, transports, or commodities it will be hard for the other parts of the market to continue to levitate on their own. A lot of the steel, coal, et al stocks that surged post Draghi comments in late July have given up most of their gains already, as has the transports index. Here is an example of what I speak of – a massive rally which in hindsight seems to be short covering, and now giving up the ghost.
As for Jackson Hole tomorrow there seems to be a concentrated effort this week to “talk down” expectations for Bernanke’s speech. If that is in the market or not at this point, who knows but the focus seems to be switching to Draghi at the end of next week instead. The first week of the month is also the one with a heavy data set (PMIs, ISMs, employment report) so one assumes the current zombie like state of the market should finally change. Futures are pressured some this morning but again since the August 3rd jump and ensuing Monday follow through rally, the S&P 500 has gone nowhere – there has been rotation under the surface from one group to another week to week but little change at all on the top line indexes.
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